Short Sales Decline 53% as Bull Market Enters Fifth Year

A trader works on the floor of the New York Stock Exchange in New York. Photographer: Jin Lee/Bloomberg

March 4 (Bloomberg) -- Investors reduced bearish stock bets
to the lowest level since at least 2007 as the bull market in
American equities begins its fifth year.

Short sales in the Standard & Poor’s Composite 1,500 Index
fell to 5.6 percent of shares available for trading in February,
down from a record 12 percent during the credit crisis and the
lowest ever in data compiled by Bespoke Investment Group and
Bloomberg starting six years ago. The last time the number of
shares borrowed and sold short approached this level, the equity
gauge lost 3.3 percent in the next three months.

Bulls say the capitulation by market bears shows the rally
remains intact and that more money will flow into stocks after
individuals sent $37.9 billion to mutual funds in January, the
most since 2004. It also means a source of demand is
diminishing, a traditional signal for caution in an aging bull
market. Less than one percent of the shares of Ford Motor Co.
and Cabot Oil & Gas Corp. have been borrowed and sold short by
speculators hoping to return them to owners once prices fall.

“When you look at short interest, and it’s low like right
now, it means people are very, very bullish about the market,”
Uri Landesman, president of New York-based hedge fund Platinum
Partners, which manages $1.15 billion, said in a Feb. 28 phone
interview. “When that happens, it’s a bearish sign, because if
all minds change, there’s downside, not upside.”

Stocks gained last week, with the S&P 500 Index rising 0.2
percent to 1,518.20, bringing the 2013 increase to 6.5 percent.
The index is up 124 percent from March 2009, when it reached a
12-year low of 676.53 and ended the worst bear market since the
Great Depression. The gauge rose 0.5 percent to 1,525.20 today.

Fifth Year

Almost $10 trillion has been restored to U.S. equities as
retailers, banks and manufacturers led the recovery poised to
enter its fifth year this week. The benchmark gauge for U.S.
equities is about 3 percent from the all-time high of 1,565.15
hit in October 2007.

Gains since 2009 came as the Federal Reserve held its
benchmark target interest rate for overnight loans between banks
near a record low and 10-year Treasuries yielded 1.84 percent
last week, compared with the decade average of 3.62 percent. The
central bank has used low rates and unprecedented bond-buying to
push investors to riskier assets where returns have been higher.
The S&P 500’s return since 2009 compares with 17 percent for
Treasuries, according to Bank of America Merrill Lynch Indexes.

Investors are adding to U.S. stock mutual funds after
pulling out almost $400 billion the past four years, data from
the Investment Company Institute in Washington show. About $16.3
billion went into stock funds the first three weeks of February,
with about $2.5 billion to U.S. equities, the trade group said
last week.

Bull Market

Laszlo Birinyi, one of the first money managers to tell
clients to buy before the bull market began, says individuals
will push stocks higher even as the rally ages and a lack of
short covering fails to elevate prices. Investor sentiment isn’t
“overly optimistic” and the market should exceed the all-time
high this year, Birinyi said.

“The idea that the public is wrong at the turns and a
contrary indicator is not true,” Birinyi said in the March
Reminiscences newsletter emailed Feb. 28. “The public is not
the only source of funds and the individual has not necessarily
made a wholesale commitment to stocks,” he added. “We continue
to look for more gains.”

Unprofitable Bets

Betting on declines has proven unprofitable. A gauge of the
most-shorted U.S. companies compiled by Goldman Sachs Group Inc.
has rallied about 9 percent in 2013. In the S&P 1,500, the
proportion of shares borrowed and sold short has been declining
since the middle of last year.

For each share speculating on losses in U.S. equities,
there are 14 betting on gains, near the highest level in at
least five years, according to data compiled by Markit, a
London-based research firm.

“Stocks are reflecting optimism in the economy, so there
are less opportunities to short,” Sarat Sethi, a fund manager
with New York-based Douglas C. Lane & Associates, which oversees
$2.6 billion, said in a telephone interview on Feb. 19.

Price swings for U.S. stocks are narrowing the most since
the Great Depression as the economy shows signs of improving.
The Federal Reserve’s zero-interest-rate policy pushed purchases
of new homes in January to the highest level since July 2008,
and consumer confidence rose more than forecast.

Mutual Funds

While investor optimism increases, corporate earnings may
not be expanding fast enough to justify additional mutual-fund
deposits, said Jason Brady, a managing director at Thornburg
Investment Management in Santa Fe, New Mexico, which oversees
$83 billion.

“The larger question to me is do the fundamentals support
that move?” Brady said in a Feb. 27 interview. “And there I’m
not so sure.”

Earnings for companies in the S&P 500 are poised to decline
1.7 percent this quarter, the first drop since 2009, according
to data compiled by Bloomberg. U.S. gross domestic product will
expand 1.8 percent, down from 2 percent a year ago, according to
the median estimate of 70 economists in a Bloomberg survey.

The highest valuations for stocks in two years may also
deter investors. The S&P 500’s price-to-earnings ratio climbed
to 15.1 last month, a level not seen since May 2011, data
compiled by Bloomberg show. That compares with an average of
16.4 since 1954.

Past Cycles

The rally is extending beyond the average length, according
to Birinyi data that shows bull markets since 1962 have a
duration of four years. Of nine advances, four have lasted
longer than the mean and the market rose for about six years
during those periods.

Diminishing levels of short selling have preceded losses in
the past. When the proportion of bearish bets dropped to near
record low levels in March 2012 and 2011, the S&P 1500 lost 3.3
percent and 0.4 percent, respectively, during the second
quarter, data compiled by Bloomberg show.

Bets against Ford, Cabot and Adobe Systems Inc. have fallen
after the shares rallied at least 10 percent since the end of
November, according to data compiled by Bloomberg.

Short selling in Ford, the second-largest U.S. automaker,
fell to a record 0.4 percent of shares outstanding last month,
from 5 percent in December, according to data compiled by
Markit. While the Dearborn, Michigan-based company gained 13
percent in December as earnings surpassed analysts’ estimates,
the stock is falling now. It dropped 2.6 percent in 2013,
compared with the S&P 500’s 6.5 percent advance.

Cabot Shorts

Bearish bets on Cabot Oil & Gas dropped to 0.2 percent of
total stock last month, near the record low, compared with more
than 5 percent in May, data from Markit show. The Houston-based
energy exploration company beat analysts’ profit estimates by 24
percent for the fourth quarter and the stock has gained 27
percent this year.

Borrowed shares of Adobe represent 1.8 percent of the
total, down from 6.1 percent Nov. 16, according to data from
Markit. The San Jose, California-based software company has
rallied 22 percent since the middle of November as sales and
profit topped analysts’ estimates.

For Deere & Co., the world’s largest agricultural-equipment
maker, short interest dropped to 1.3 percent last week, compared
with 3.6 percent in September, Markit data show. The stock is up
7.1 percent since then, compared with the S&P 500’s 4.9 percent,
as the Moline, Illinois-based company boosted its dividend and
posted better-than-estimated earnings.

Healthy Market

Short sellers represent 2.4 percent of Johnson & Johnson’s
shares today, down from 8.1 percent in June. The world’s largest
seller of health-care products exceeded fourth-quarter
projections when it reported Jan. 22. The stock is up 9.4
percent for 2013.

“Short interest is necessary for a healthy market,” Jeff
Sica, president and chief investment officer at SICA Wealth
Management, which oversees more than $1 billion, said in a phone
interview from Morristown, New Jersey.

“When you have a market where investors are all in, there
will no longer be short covering,” said Sica, who started
reducing bearish bets in mid-2011 to the current 5 percent of
assets. “As short interest has continued to decline, I see it
as a sign of a market top.”